Mutual Fund News

It's not how it performs, it's about commission

What really drives the fund industry

By ANDREW WILLIS

Wednesday, June 23, 2004

When AIC Ltd. started to lose investors, the company didn't look at changing course on poorly performing mutual funds to set the ship right.

Instead, as it bled $330-million through the first five months of this year, AIC opted to boost the amount of money it paid the stockbrokers, insurance agents and financial planners who embrace its "buy, hold and prosper" mantra. Long-term trailer fees paid to advisers rose by 0.025 percentage points each year, to 0.625 per cent for those who kept their clients in AIC funds for six years.

Welcome to what really drives the mutual fund industry. It's not about hot performance, snappy service, or those memorable advertising campaigns with the Hulk and Spiderman. It's about the commissions, the millions of dollars in fees that fund companies fork out each year to brokers and planners who peddle their goods.

Fund families that pay generous fees can count on attracting attention. Since there are now more mutual funds in North America than there are stocks listed on the New York Stock Exchange, being top of mind with advisers is increasingly critical.

Mutual funds remain products that are sold to most investors by their financial advisers, not bought off the shelf like soap or breakfast cereal. As long as this remains true, the fund families that prosper will be those that treat their various sales agents well.

So AIC ratchets up trailer fees to keep advisers happy. And over at CI Investment Management Inc., executives fiddle with the commissions they pay to those who sell in-house Optima funds in order to placate the 1,000 planners who work in CI's newly acquired Assante sales network.

When it comes to fees, it's always been thus. Even when its funds boasted red-hot performance, Altamira Investment Services Inc. couldn't catch on with the broker crowd. But when the company struck a deal with Triax Capital Holdings Ltd. that saw advisers earn a 6-per-cent selling fee on a small-cap Altamira-managed fund, it suddenly had a $200-million hit on its hand.

This doesn't mean that the fund companies aren't sensitive to investor concerns about high fees and who gets what slice of the pie. Mackenzie Financial, for example, goes out of its way to point out just who gets what out of the 2.51-per-cent management expense ratio, or MER, on its Ivy Canadian Fund.

An investor with $10,000 in the flagship fund would pay $251 annually to the company. Of this, Mackenzie actually gets to keep only $102, which goes to pay its portfolio managers and other corporate expenses. Taxes and bookkeeping take up a bit of the remainder.

But most of the money, a full $98 to be precise, goes to investment dealers to compensate their employees for initially selling the fund, through sales commissions, and providing continuing service with trailer fees.

The fear for investors is that a focus on fees by advisers might get in the way of good advice, and potential profits. Remember, the fees captured in the MER cut into performance over time.

For example, few advisers will sell their clients funds from the trailer-fee-free family at Phillips Hager & North. They prefer to recommend a traditional fund company, or what's known as a "wrap account" of several funds, that also comes with a commission for the seller.

The MERs at PH&N are half that of its peers. So a $25,000 investment that an investor holds for 15 years, and earns 8 per cent annually, will be worth $11,283 more at PH&N than at a fund with an industry-average MER of 2.4 per cent.

There's little chance the industry will take the lead in cutting trailer fees. If anything, these commissions are becoming more important. The fund families know they need to compensate brokers and planners for the time they spend on client service, in order to keep their orders coming.

One marketing veteran of several fund companies says: "We know that if we want to get an adviser to pay attention to our material, we simply need to write 'Compensation Information Enclosed' on the outside of the envelope, and send it out."